The ESOP as the Majority Stockholder – Part I

Colin M. Henderson ­ Spring 2003

Introduction

Employee stock ownership plans (ESOPs) have been on the corporate landscape for almost three decades. In their early history, ESOPs typically acquired (or received a contribution of) a minority ownership interest in the equity of the sponsoring private or public company. In the privately-owned company, where the stock was acquired in a purchase transaction involving a party-in-interest, that stock ownership was typically in the range of 30 to 49 percent of the company’s outstanding equity. The selling stockholders usually retained the controlling ownership interest.

ESOP fiduciaries found some comfort in the fact that non-ESOP shareholders retained a significant ownership stake in the employer corporation. Typically, the non-ESOP “other shareholders” were the founders, board of directors, and/or professional managers of the business.

With the passage of time, second- and third-stage ownership transition transactions moved some of the earlier ESOPs into the position of owning more than 51 percent of the company equity, thereby becoming the controlling stockholder in the employer corporation. Also, with the passage of time, change typically occurred in the boards of directors and in the management of these ESOP-owned corporations, as employee/director departures and ownership succession occurred.

More recently, the advent of the S corporation ESOP created additional incentive for an ESOP to own significantly all of the employer corporation equity. This incentive relates to the very favorable federal corporate income tax treatment that results when an ESOP owns 100 percent of the equity of an S corporation.

This article will not provide an explanation for the economics of S corporation ESOPs. That subject has been amply covered in the professional literature. Rather, the focus of this article is the phenomenon of ESOPs becoming the controlling or the sole stockholder of the sponsoring company.

The fiduciaries of such ESOPs need to reconsider their duties in light of the ESOP’s ownership control position. In addition, in an ownership control ESOP, non-independent fiduciaries (inside fiduciaries) are placed in an increasingly difficult circumstance of managing the inherent conflict of interest when company business prospects turn bleak.

Part II »